Clarity in financial reporting - April 2023 monthly newsletter

Why does it matter? Global sustainability reporting developments may have an impact on Australia’s near term climate-related financial disclosure regime.

What’s happened?

The International Sustainability Standards Board (ISSB) held a supplementary meeting in early April 2023 to consider additional transitional provisions for its forthcoming IFRS Sustainability Reporting Standards, IFRS S1 General Sustainability-related Disclosures and IFRS S2 Climate-related Disclosures.

The ISSB decided to provide transitional relief from the disclosures in IFRS S1 so that entities would only be required to provide climate-related disclosures in the initial year of application (i.e. annual reporting periods beginning on or after 1 January 2024, as agreed by the ISSB at its February 2023 meeting). In other words, entities would only be required to provide the disclosures required by IFRS S2 in the initial year of application.

Although broader sustainability-related disclosures would not be required to be provided in the first year of application, entities would still be required to apply IFRS S1 requirements where they relate to climate-related disclosures, such as those related to materiality and the connectivity of information with the financial statements.

Impact on transition

These latest developments add to a number of other transitional relief provisions that have been previously agreed to by the ISSB. In summary, entities applying IFRS Sustainability Disclosure Standards can elect in the first year of application not to:

• Provide sustainability-related risks and opportunities other than climate-related information (i.e. only provide the disclosures required by IFRS S2)
• Provide comparative information in their first year of applying IFRS S1 and IFRS S2 (which means in an entity’s second year of application, for an entity who elected to defer the application of IFRS S1, comparative information would only be required in respect of the climate-related disclosures in IFRS S2)
• Provide sustainability-related disclosures at the same time as the related financial statements (thereby providing additional time for entities to prepare their first set of climate-related disclosures, rather than aligning with financial reporting timeframes)
• Disclose Scope 3 greenhouse gas emissions under IFRS S2 (again, for an entity applying this relief, in the second year of applying IFRS S2 the entity would thus not be required to provide comparatives for Scope 3 emissions)
• Use the Green House Gas Protocol to measure emissions (where a different approach is currently being used).

Together, this relief will provide an easier and phased transition to sustainability reporting whilst permitting an early application of IFRS Sustainability Disclosure Standards to respond to urgent investor demand for information about climate-related risks and opportunities.

What does this mean for Australia’s climate-related disclosures?

As we have reported in earlier editions of this newsletter, Australia is expected to implement a mandatory climate-related financial disclosure regime, initially focused on large listed entities and financial institutions.

Treasury and the AASB are focused on a “climate first” approach to sustainability reporting, which is consistent with the latest ISSB developments. The Federal Government has signalled a broadening of sustainability reporting in due course but formal proposals and funding beyond climate-related financial disclosures have not been made at this stage.

In terms of timing, although the initial Treasury consultation on climate-related financial disclosure is not definitive, it suggests initial mandatory reporting by large listed and financial institutions could commence from the 2024-2025 financial year (i.e. in line with the ISSB standards).

Accordingly, apart from the high-level consultation paper and an introduced Bill to effectively provide temporary authority for the AASB to formulate sustainability standards, the necessary legislative and institutional framework for implementation of mandatory sustainability reporting in Australia is unclear at this stage.

We continue to recommend that entities closely follow developments in this area and urgently prepare for climate-related financial disclosures from as early as 2024-2025 financial years.

Why does it matter? Public companies need to prepare to provide information about subsidiaries in a new ‘consolidated entity statement’ to be included in financial reports for financial years commencing on or after 1 July 2023.

What’s happened?

The Federal Treasury is consulting on proposals to require additional disclosures about subsidiaries in the annual report of public companies. The proposals would apply for financial years commencing on or after 1 July 2023.

Under the proposals, a new statement, the “consolidated entity statement” would be introduced into the financial report of public companies (both listed and unlisted) through amendments to the Corporations Act 2001. The consolidated entity statement would include details of entities that form part of the consolidated entity as at the end of the financial year.

The details would include each entity's:

• Name and type (body corporate, partnership or trust)
• Place of incorporation or formation and the ownership interest held (if the entity is a body corporate)
• Involvement with other entities as a trustee of a consolidated trust, partner in a consolidated partnership or participant in a joint venture within the consolidated entity
• Tax residency (i.e. Australian resident or foreign resident), and if a foreign resident, a list of each foreign country in which the entity was resident.

These details would be required when the entity is required to prepare consolidated financial statements. Where the entity is not required to prepare consolidated financial statements, the consolidated entity statement would instead include a statement to that effect (i.e. the statement would still be required, but simply make the statement rather than list subsidiaries).

The directors would be required to include a statement in the director's declaration that the consolidated entity statement is “true and correct”. Furthermore, the declaration by the chief executive officer and chief financial officer of listed entities would also be extended to include a statement that the consolidated entity statement is “true and correct”.

Because the consolidated entity statement would form part of the financial report, it would also be subject to audit through the operation of s.301 of the Corporations Act 2001.

The proposals for the disclosure of subsidiary information were announced in the October 2022 Federal Budget as part of the Federal Government's multinational enterprise tax integrity and transparency measures. The explanatory materials accompanying the draft legislation explains that the consolidated entity statement proposal has been incorporated into financial reporting requirements of the Corporations Act 2001 on the basis this should minimise compliance burdens.

The consultation closed for comment on 13 April 2023 and the proposals are expected to be incorporated into a future Bill to be placed before Parliament.

More information:

• Treasury consultation Disclosure of subsidiary information
• Federal Budget October 2022 Budget Paper No. 2 (page numbered as 17).

Why does it matter? The Senate’s passing of amendments to Australia’s Safeguard Mechanism will have immediate impacts on financial reporting for entities whose facilities are affected.

What’s happened?

On 30 March 2023, the Parliament passed the Safeguard Mechanism (Crediting) Amendment Bill 2023. The passage of the Bill is part of the Federal Government’s commitment to reduce Australia’s greenhouse gas emissions by 43% below 2005 levels by 2030. The amendments will become effective from 1 July 2023.

The amendments made by the Bill are complex. In addition, in order to secure passage of the Bill in the Senate, the Government agreed to a number of amendments that may make compliance more burdensome than the initial Bill may have contemplated.

What is the Safeguard Mechanism?

The Safeguard Mechanism applies to large emitters in the industrial sector and requires them to keep their emissions at or below a ‘baseline threshold’. Facilities must reduce their emissions below the threshold and offset any excess by purchasing or surrendering carbon credits.

The mechanism applies to all facilities (i.e. it applies at a facility, not entity, level) with Scope 1 (direct) emissions of at least 100,000 tonnes of CO2- equivalent per annum. There are currently around 215 facilities that are subject to the Safeguard Mechanism, which together account for slightly less than 30% of Australia’s total greenhouse gas emissions.

Under the changes introduced by the Bill:

• Each facility’s baseline threshold will reduce by 4.9% per annum until 2029-2030 (with limited exceptions and some flexibility, and on a rolling five-year basis after that time), with entities using more than 30% offset to meet this requirement required to explain to the Clean Energy Regulator their decision for doing so
• A new tradable credit, called a ‘Safeguard Mechanism Credit’ (SMC), will be introduced, which arise when a facility beats its baseline threshold reduction. These can be sold to other facilities subject to the Safeguard mechanism to allow them to meet their baseline targets
• In addition to SMCs, entities will be able to purchase Australian Carbon Credit Units (ACCUs), with Government-held ACCUs being available for purchase at a capped price of $75 per tonne CO2-equivalent (increasing at CPI plus 2% per year)
• Australia’s total gross emissions from all facilities will be required to fall from 140 million tonnes to 100 million tonnes in the period to 2030, and also be capped in absolute terms.

Accounting implications

Entities with a facility that is subject to the revised Safeguard Mechanism will need to consider the impacts as part of financial reporting, including at June 2023.

Examples of accounting impacts that should be considered include:

• Impairment – The impacts of the revised mechanism should be forecast in recoverable amount models, including expected payments for carbon offsets and indirect impacts such as expected changes in demand for products. Fair value models may also incorporate the impacts of anticipated capital expenditure expected to be put in place to abate emissions in order to meet the reducing baseline threshold
• Useful lives and residual values – The revised requirements may impact the expected useful lives or residual values of plant and equipment and other assets where they are to be replaced, or where facilities are to be exited earlier than expected due to the new requirements. This may also extend to intangible assets arising from business combinations involving facilities subject to the mechanism
• Provisions – An obligation to offset emissions arises as an entity emits CO2e-equivalents and a provision should be recognised at reporting date to reflect the estimated emissions produced but not yet offset at the end of the reporting period. Onerous contracts may arise where additional costs arising from the mechanism result in the total costs of servicing contracts exceeding the benefits expected to be received. In addition, where the expected exit date from facilities is brought forward, equivalent changes should be made relating to the changes in expected timing of restoration and rehabilitation provisions
• Intangible assets and inventory – Intangible assets (or in some cases inventory) may arise from ACCUs and SMCs generated or purchased by the entity (see also iGAAP Chapter A9 Section 3.3.8, subscription required)
• Deferred tax assets – Additional outlays expected in order to meet the decreasing baseline threshold may result in lower forecast taxable income, impacting the measurement of deferred tax assets
• Employee incentive schemes – The measurement of existing share-based payment, bonus and other schemes may be indirectly impacted by the scheme, particularly where outcomes are linked to carbon targets or profitability. Carbon-linked targets in share-based payment schemes would generally be considered other performance conditions under AASB 2 Share-based Payment
• Expected credit losses – Entities that have customers that are subject to the Safeguard Mechanism may need to consider whether the new requirements represent a material increase in credit risk in relation to those customers’ receivables, which may result in changes to expected credit loss allowances.

Why does it matter? Being aware of recent developments allows a timely and informed response.

ASIC updates regulatory guide on solvency statements

ASIC has published an update to Regulatory Guide RG 22 Directors’ solvency declaration, replacing outdated references and terms and including recent legislative developments (e.g. the corporate collective investment vehicle (CCIV) regime).

The stated objectives of RG 22 are to:

• Explain the requirements for the directors’ solvency declaration under s.295(4)(c) and s.303(4)(c) of the Corporations Act 2001 (which requires a declaration by the directors “whether, in the directors’ opinion, there are reasonable grounds to believe that the company, registered scheme or disclosing entity will be able to pay its debts as and when they become due and payable”)
• Outline the obligations of directors when making the declaration on the solvency of an entity
• Outline the obligations of the auditor in relation to the directors’ solvency declaration.

Some of the points noted in the guide include:

• Directors must have reasonable grounds for believing that the entity is able to pay its debts as and when they fall due. The guide includes examples of the wide range of information that directors should consider in meeting the reasonable grounds criteria
• Directors must consider the entity’s capacity to pay debts it has incurred as at the date of the directors’ declaration, rather than as at the end of the financial yearASIC considers that the words “will be able to pay its debts as and when they become due and payable” (s.295(4)(c)) introduce a prospective element into the declaration, and accordingly, future debts should be considered to the extent that they will compete for payment with the debts existing at the date of the declaration
• The solvency declaration is part of the financial report, and the auditor must form an opinion about whether the report complies with the requirements of the Corporations Act 2001. Auditing standards require the auditor to obtain reasonable assurance as to whether the financial report as a whole, is free from material misstatement. ASIC notes that whether the entity is solvent could be expected to be material in nature and that it expects auditors to consider information such as outlined in RG 22 in undertaking their work.

IASB to focus on climate-related risks in financial statements

At its March 2023 meeting, the International Accounting Standards Board (IASB) agreed to commence a narrow-scope maintenance project on climate-related risks in financial statements. In progressing this project, the IASB staff expect to explore:

• The nature of perceived shortcomings with financial statements in communicating information about climate-related risks
• Requirements in IFRS® Accounting Standards that might not be sufficiently clear about whether and how the effects of climate-related risks should be considered when preparing an entity’s financial statements
• Reasons for entities arguably not considering (or not adequately considering) the effects of climate-related risks when applying the requirements
• Possible courses of action available to the IASB together with the pros and cons of each.